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Tuesday, 24 October 2017

On Treasuries, carry trades and Ed's dread

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Anthony Peters gets unusually worked up about about a US auction.

It has been a while since I last got anything close to excited over a US Treasury refunding auction, but last night’s sale of US$29bn of 2yr notes was an outstanding event and one which should not go unnoticed.

Apart from the strong bid/cover ratio of 3.56, it was the power of the indirect bidders which caught the eye. Just under 41% of the bonds went to direct bidders which generally includes, and is largely made up of, foreign central banks.

In the more recent past, direct bidders – these with bids lodged directly with the Treasury and not through the primary dealer network – have been taking down under 30% of the auction paper. This points to the US Treasury market having become the “go to” place which is, given the strength of the currency and the precipitous steepness of the front end of the curve, no huge surprise. (I wouldn’t want to speculate on which is the chicken and which is the egg, but as a total aside, I now know the answer to that one. Chickens are birds and birds are derived from dinosaurs. Dinosaurs laid eggs. That should settle the matter for once and for all.)

I’m not a great fan of cross-market, cross-currency sovereign-spread plays but I cannot help noticing that US 3yr yields are higher than German 10yr yields. On a risk/reward basis, a total return investor – which is what central banks tend to be – is probably better off playing the carry trade at the front end of the Treasury curve than sticking one’s neck out in either euros or yen, even with the cheaper cost of cash.

With that in mind, today’s 5yr and tomorrow’s 7yr note auctions – trading in the WI market at 1.80% and 2.25% respectively – look like safe bets, even though the old wisdom of a three auction series was that one would be good, one would be average and one would end up being pretty poor. I suspect this batch of refunding sales might break the mould.

With the risk of rate moves rising – Esther George of the Kansas Fed, one of the chief hawks, spoke yesterday and said the rates “should have been off zero at this point” – there might be a bunching in the front end. Bear flatteners have to be played in the forward market while the spot market is the place for bear steepeners.

What Ed said…

Elsewhere and on a very different note, the UK’s Labour Party is holding its annual conference in my own home town of Manchester. (Before you ask, no, I do not and never have supported Manchester United.) The newspapers here in the UK are full of comment on Ed Milliboy’s leader’s speech of yesterday which he gave without notes. He spoke freely for over an hour, but sadly forgot his bit on the economy, the deficit and immigration.

He did, however, promise to “heal the National Health Service” – from precisely what it needs healing he did not tell us – and vowed to hire 20,000 more nurses, 8,000 more GPs, 5,000 more care workers and 3,000 more midwives and pay for it, amongst other measures, by a windfall tax on tobacco companies. How one funds the life-long careers of 36,000 people on the back of a one-off tax take escapes me, but I am happy to have it explained to me by those with a greater understanding of public sector finance.

Also, given voter sensitivity to the issue of immigration, promising to rapidly pack 36,000 people into the healthcare and welfare support system without importing resources (I think that counts as immigration) might make it hard for him to square the circle. Perhaps better for him that he also missed that bit out of the speech.

The most basic demand of political leadership, namely a vision of how to create the wealth required to allow the country to offer a no-holds-barred health service was blatantly missing. I’m happy to believe that he got carried away and forgot to speak on it but many out there are already accusing him of having intentionally skipped over the bits for which he had nothing meaningful to say.

One way or the other, it was an embarrassing moment and one which will not necessarily endear him to the floating voter.

Apart from that, I must confess that I thought it to be a quite appealing speech which lacked nothing more than a call to eat the rich.

Finally, to all my Jewish readers I would like to extent my best wishes for the New Year and offer Shana Tova.

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